Banks have much cleaner books now; where did all NPAs go?

The April-June quarter earnings of Indian banks confirm the trend of steady improvement in asset quality. These lenders have much cleaner books now. Or at least that’s what the numbers reported with the April-June quarter earnings so far suggest.
Let’s first take a look at the numbers of the larger banks.

ICICI Bank, for example, has managed to bring its gross bad assets ratio down 19 basis points on a quarter-on-quarter basis to 3.4 percent and compared with 5.15 per cent a year ago, clearly a good improvement. Similarly, Axis Bank, another key lender in the private sector, reported gross non-performing asset (NPA) ratio falling to 2.76 percent in June, down from 2.82 percent in March and 3.85 percent in the same quarter of the previous financial year.

HDFC Bank, on the other hand, reported GNPAs at 1.28 percent against 1.47 percent in the same quarter last year but higher than the 1.17 per cent in the preceding quarter. Canara Bank, a big name among state-run lenders, too announced an improvement in numbers with GNPAs falling to 6.98 percent versus 8.50 percent in the same quarter last year.

Overall, if one looks at the industry as a whole, total gross NPAs of Indian banks have declined to less than 6 percent as of the end of June 2022, from 12-13 percent a few years ago.

How did this happen?

Clearly, the big bad loan problem Indian banks witnessed half a decade ago has been addressed to a large extent. In fact, this improvement is not sudden but gradual, in line with the improvement in the broader economy. For this, one should thank the Reserve Bank of India (RBI) under former governor Raghuram Rajan.

The whole improvement in NPAs started way back in 2015 when the RBI Rajan kicked off the massive asset quality review. This prompted banks to disclose hidden bad loans on their books and provide for each and every loan account that was in the default category (90 days or more overdue). Banks were tasked with setting aside money for such written-off loans, which are called provisions. Higher provisions impact the asset quality of banks.

Subsequently, the NPA numbers have fallen.  Gross NPAs reduced to Rs 7.73 lakh crore as of December 31, 2021, against Rs 10.36 lakh crore as of March 31, 2018, due to transparent recognition of stressed assets, the government informed the Rajya Sabha in March this year, PTI reported.

Simultaneously, the efforts to resolve NPAs—the existing stock—began. The introduction of the Insolvency and Bankruptcy Code (IBC) in 2015 helped push large-ticket NPA cases to faster resolution in a time-bound manner.

Also, the gradual post-pandemic recovery in the economy and high caution exercised by lenders in awarding fresh loans translated into a decline in fresh incremental slippages. In the cases of Axis Bank, gross slippages during the June quarter were Rs 3,684 crore compared to Rs 3,981 crore in Q4FY22 and Rs 6,518 crore in Q1FY22.

But that doesn’t mean all is well

Granted, banks have much cleaner books now. This enables them to start afresh with new lending proposals. However, this doesn’t mean the stressed assets have been resolved. They remain somewhere within the financial system. These loans are only written off from the books of banks. A large part of it still remains within the system.

To give some numbers, in the 10 years between 2010 and 2020, Indian banks wrote off loans worth around Rs 8,83,168 crore, a significant chunk of which came from government-owned banks, the latest data from the Reserve Bank of India shows.

Of this, public sector banks (PSBs) alone wrote off Rs 6,67,345 crore worth loans since 2010. This is about 76 percent of the total written-off loans in the decade, while private banks wrote off loans worth Rs 1,93,033 crore, constituting about 21 percent of the total chunk. Foreign banks wrote off Rs 22,790 crore loans or 3 percent of the total write-off, the RBI data showed.

“Write-offs and provisioning are the main reasons for this improvement,” said the head of an asset reconstruction company on condition of anonymity. In FY 21 alone, banks wrote off around Rs 2 lakh crore worth loans. “Corporate loans will be just written off or resolved for very small recovery (sic),” said the person.

What about recovery?

This is the problem area for banks. The actual resolution within the IBC system has been less compared with the cases of liquidation. From December 2016 to March 2022, 47 percent of corporate insolvency processes went into liquidation, compared with 14 percent that ended in a resolution plan, showed data from the Insolvency and Bankruptcy Board of India.

Out of a total of 5,258 corporate insolvency proceedings initiated under the code till March, only 3,406 have been closed. Among those closed, as many as 1,609 proceedings have ordered liquidation, while 480 have ended in approval of resolution plans. Further, till December 2021, only 457 cases had yielded resolution plans.
In most cases, lenders end up taking a huge haircut, meaning they actually get back only a very small percentage of the money they are owed.

Then there is the plan for the so-called bad bank. The actual progress of the bad bank plan—the creation of a separate entity that would house the NPAs of banks—is yet to be seen. The plan is to move about Rs 2 lakh crore worth of loans, starting with Rs 50,000 crore this fiscal, to the bad bank. This is an ongoing process. But here as well, unless there are buyers in place for these assets or there is a solid resolution plan, these assets will remain stuck within the financial system.

“Banks have a cleaner book now, which is good since banks can start on a cleaner slate. But the stress remains within the system. It is difficult to quantify the problem,” said Madan Sabnavis, chief economist at Bank of Baroda.

To sum up, unless the stock of bad assets are resolved either through resolution or outright sale, the stress will remain in the financial system. Strong economic recovery holds the key. So far, the improvement seen in NPA numbers are mostly aided by large write-offs and not actual recovery.